First Federal Bank Blog

What is Business Valuation?

A business valuation appraises the monetary value of your company. While a business valuation is an essential part of selling a company, it can be useful even if you aren’t looking to sell your small business. An accurate, up-to-date business valuation can enable you to quickly respond to an unexpected opportunity or setback. For instance, if you want to bring a new business partner on board or grow your company with a loan, you’ll need an accurate valuation of your company. Similarly, if a partner of LLC member leaves the company, you’ll need an up-to-date valuation to calculate the buy-out price. There are many factors to consider when choosing a business valuation method. Here are some tips to help you pick the right approach for your enterprise.

Asset-based approach

If you take an asset-based approach, it will find the sum of both the company’s tangible assets, such as equipment and property, as well as its intangible assets, such as copyrights and patents. According to Mike Handelman, a contributor to Inc. and the general manager of BizQuest.com and BizBuySell.com, asset-based business valuations are generally used for the liquidation or the sale of a defunct company. There are two main ways to conduct an asset-based business valuation: the going-concern approach and the liquidation approach. The first method uses your company’s balance sheet and some simple math — just subtract your company’s total liabilities from its total assets to find the book value. For the second approach, you’ll calculate how much money would be left over if you sold your business’s assets and paid off its liabilities. The remainder is called the liquidation value. If your company is a sole proprietorship, your calculations will get a bit more complicated. That’s because your business assets are in your name, making it difficult to separate which assets belong to you, and which belong to the company. If you’re selling your company, you’ll have to work closely with the buyer to figure out which assets you’re selling.

Earning-value approach

When you choose the earning-value approach, you’ll base your business valuation on the company’s potential to generate money in the future. Susan Ward, an IT consultant and longtime contributor to The Balance, explains that this common business valuation method can be performed in two ways — by capitalizing past earnings and by discounting future earnings. To capitalize on your company’s past earnings, average your company’s records to account for any atypical spikes or losses in revenue. You’ll then multiply that figure by a capitalization factor, a figure that considers both the business’s expected rate of return and the risk that it won’t achieve its expected profits. If you want to calculate discounted future earnings, you should average your company’s future earnings, then divide this averaged figure by the estimated capitalization factor. Conducting a valuation of a sole proprietorship is more involved since your skills, professionalism and expertise play a large role in your customer’s loyalty. If you’re selling a sole proprietorship, Ward recommends focusing the valuation on the estimated amount of business that you could lose.

Market-value approach

This approach calculates your company’s value by using the recent selling prices of similar businesses. It’s similar to using real estate comps to find home values. However, this approach won’t work unless there’s data from plenty of similar companies. The market-value approach won’t work for sole proprietorships — it’s virtually impossible to find public sales data on companies held by individuals.

You may find that you can get a more complete picture of your company’s value by using multiple business valuation methods. To get a clear, balanced and professional valuation, Jean Murray of The Balance Small Business recommends consulting a business appraiser. Also, consider consulting your business partner and financial planner for greater insight into your enterprise.